Public or Private: What Should be the Approach for Future Banking?

Abstract

Banking in India forms the base for the economic development of the country. Over years, the banking sector in India has witnessed several reforms with finally the Finance Minister Nirmala Sitharaman announcing the administration’s plan to privatise two public sector banks, as part of a larger plan to privatise even more PSBs. India, in its history, has witnessed the conversion of private sector institutions to the public sector through the nationalisation of 14 commercial banks in 1969 (First Phase of Nationalisation) and 6 other banks in 1980 (Second Phase of Nationalisation). However, this would be the first time that India is witnessing the privatisation of national banks. This would cause a dilemma regarding how to initiate the process of privatisation especially in the legal parlance like whether to enact new laws or to nullify the existing laws or to amend it or in case of amendment, what kind of an amendment is required. Such an action would have social, political and economic consequences. However, the most important aspect would be to weigh the pros and cons of such an action and decide whether privatisation can serve as the panacea for the crisis.

Banking in India forms the base for the economic development of the country. Over years, the banking sector in India has witnessed several reforms with finally the Finance Minister Nirmala Sitharaman announcing the administration’s plan to privatise two public sector banks, as part of a larger plan to privatise even more PSBs. The degrading financial position of the public sector banks despite years of capital injections and governance reforms was not enough to improve the financial position of these banks. This has increased the burden on the government to provide equity support year after year. Moreover, the Financial Stability Report by the RBI suggests higher NPAs (Non-Performing Assets) and loan losses as the impact of the covid pandemic. These were the major reasons behind the government’s idea of privatising public sector banks. However, the names of the two banks that are to be privatized among the 12 nationalised banks would be decided based on a three-committee-level process involving the NITI Aayog, the Core Group of Secretaries and the alternative mechanism for final approval.

The point to be noted in this scenario is that India, in its history has witnessed the conversion of private sector institutions to the public sector through the nationalisation of 14 commercial banks in 1969 (First Phase of Nationalisation) and 6 other banks in 1980 (Second Phase of Nationalisation). The nationalisation process then was enabled with the enactment of the Banking Companies (Acquisition and Transfer of Undertakings) Act 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act 1980 respectively. However, this would be the first time that India is witnessing the privatisation of national banks. This would cause a dilemma regarding how to initiate the process of privatisation especially in the legal parlance like whether to enact new laws or to nullify the existing laws or to amend it or in case of amendment, what kind of an amendment is required. The below mentioned are the main legal hurdles that the government is required to look into:

1. Whether to repeal the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980? - Amendments would be required in the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 for privatisation. These Acts led to the nationalisation of banks in two phases and provisions of these laws have to be changed for the privatisation of banks.

1. Before repealing the bank nationalization laws of 1970 and 1980, a procedure has to be developed for the transition of the Public Sector Banks from under these Acts to the Companies Act. Once a bank is privatised, it no longer falls under the purview of Banking Companies (Acquisition and Transfer of Undertakings) Acts, instead would come under the Companies Act. Thus, a procedure has to be developed for this transition.

2. Ring-fencing retirement funds of the employees: The pension funds of these banks will need to be ring-fenced so that the retirement benefits of the employees of these banks, is not impacted in case the banks fail even after privatisation. Further, if the new owner feels the need to make the workforce lean and thin and let go of the older employees, they can offer voluntary retirement schemes (VRS) to such employees, wherein the terms are in no manner less favourable than the VRS applicable before disinvestment.

3. Issues of PSU employees on Privatization: Change in the terms of services of the employees is a major concern. Alteration in the terms and conditions of the services is to be addressed through provisions in the Share Purchase Agreement (SPA) entered into with the strategic partner at the time of the strategic sale. Moreover, with the privatisation of a PSU, the reservation policy for SC/ST employees may be diluted or even nullified. The Share Purchaser shall not deviate from the principles and policies followed by the government for the benefit of the members of the Scheduled Castes/ Scheduled Tribes, physically handicapped and other socially disadvantaged categories of the society. Further, in the event of any reduction in the strength of the employees of the Company, the Share Purchaser shall use its best efforts to ensure that the physically handicapped persons are retrenched at the end.

4. Court cases: The Government may face oppositions from the Unions who can approach the courts fearing mass retrenchment post-privatisation. There could also be public interest litigation by interested parties. The long inordinate delays in the execution of plans and disposal of cases would further aggravate the situation. Moreover, the courts would be placed in a quandary regarding how to deal with the cases in which the privatized banks are one of the parties when they were in the status of PSB’s.

5. The voting rights cap of 10% for a non-government shareholder irrespective of his/her shareholding is among the key constraints identified. Section 12(2) of the Banking Regulation Act states "No person holding shares, in respect of any shares held by him, should exercise voting rights on poll in excess of 10% of the total voting rights of all the shareholders". The voting rights cap for a non-government shareholder is 10% irrespective of one’s shareholding as per the provision. In a case where banks are privatised, there arises a need to increase this share. However, no clarity as to this has been provided by the government so far.

6. As per the Banking Regulation Act, 1949, that no shareholder of a banking company, irrespective of public or private, can exercise voting rights of more than 26%. A more liberal approach needs to be adopted by way of an amendment in case of privatised banks to provide higher voting rights to promoters.

7. RBI to change its current stance which is towards limiting promoter control. On privatisation, the government’s control in these banks substantially reduces and the promoters need to be replaced in the position. For promoters to assume more control over the banks, it is necessary that RBI have to change the current stance which limits the promoter’s control.

8. Providing higher voting rights to the promoters. This would reduce the government’s stake and control of the privatised bank. There are high chances for the promoters to change the objectives of the privatised banks.

Apart from the legal hurdles, a conversion into private banks would have large social consequences because of its wide financial linkage that a public sector bank has with other parts of the economy. Government cannot practically afford the political fallouts of banking failures; all losses would be ‘social obligation’ that needs to be borne by the state irrespective of the ownership structure, which would eventually burden the taxpayers. The motive of private banks being profit maximisation, social obligations such as ensuring social welfare, credit availability to the needy sectors such as agriculture, small and village industries, checking private monopolies, reducing regional imbalance etc. are easily forgone and as history in 1969 and 1980 reveals, there are high chances that the losses would eventually be ‘nationalised’.

Even if it is assumed that the government was able to overcome the above-mentioned hurdles effortlessly or satisfactorily, and the banks are privatised, the parties buying stakes in these banks are likely to face some challenges. Liquidating the non-performing assets, especially the stressed assets in a timely manner and recovering whatever is recoverable would be the major challenge. Considering the sluggardly and meandering pace at which IBC proceedings are going, it would take a very long time for the new owners to recover anything. Another challenge would be the cost to be incurred by the new stake owners in technology up-gradation as most of these banks have not gone in for any major technology up-gradation over the last few years. Managing employee cost and industrial relations would be another major concern. Employee morale in public institutions is generally low and would be further impacted if there are mass retrenchments. In such circumstances, the privatised bank may adopt schemes like voluntary retirement, part-time, contract jobs, work from home etc. as a temporary resolution. Further, training, coaching and mentoring are needed to be provided so that the workforce in these banks are geared to work in a competitive and fast-paced environment.

Privatisation can be adopted as one element of the overall reform policy, but considering it as the ultimate panacea in the banking sector reform, mainly because it is a politically easy thing to do right now, is fraught with more adverse consequences. Privatisation also cannot help to reduce the problems that made the government think about this option. It would be a better option to improve the governance and management of PSBs by implementing the recommendations of the PJ Nayak committee instead of privatisation being considered as the need of the hour. Constituting a Risk Management Committee and revamping credit governance architecture in nationalised banks may help to reinforce efforts to minimise credit costs and enhance the efficiency of credit allocation. Another suggestion would be to make the PSBs into a corporation like Life Insurance Corporation (LIC). This would facilitate in providing more autonomy to the public sector banks than from the existing dual-control system of power exerted by the RBI and the Government of India.

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